Edited version of private advice

Authorisation Number: 1051527627106

Date of advice: 11 October 2019

Ruling

Subject: Permanent establishments

Question

Will the Tax Treaty apply to the government subsidies (Subsidies) received by AusCo, as agent for ForeignCo, such that the Subsidies are not assessable income of ForeignCo for Australian tax purposes?

Answer

Yes

Relevant facts and circumstances

Background

ForeignCo is a non-resident company for tax purposes.

ForeignCo has a large market capitalisation with substantial assets, and globally it is involved in numerous big-scale projects and businesses which also employ a significant number of employees.

ForeignCo imports significant amount of raw materials from Australia for use in one of its main businesses that form part of its global enterprise.

The raw materials are purchased by ForeignCo through its trading activities in Australia and also through its passive investments in joint ventures held by its Australian subsidiary, RelatedAusCo. However, no operational or management functions are carried out by ForeignCo or its related entities in respect of the joint ventures.

ForeignCo is also involved in joint research with several organisations in Australia, and is also involved in another joint venture passive investment which does not entail operational or management functions carried out by ForeignCo or its related entities.

AusCo is a recently incorporated resident company for tax purposes, and is wholly owned by ForeignCo.

The Project

ForeignCo is a participant, along with other entities (Project participants) in a world-first pilot project (Project) involving scientific research located in Australia. ForeignCo is not related to any of the other Project participants.

The Project aims to demonstrate a viable and world-first integrated supply chain of producing goods from raw materials (Goods) and transporting and storing the Goods for use by one of ForeignCo's main businesses.

The Project will therefore also determine whether the Goods can be produced from the raw materials and the amount of Goods that can be produced by a commercial facility operating at 100% capacity.

If the Project is successful, the Goods produced by the Project itself will have no commercial value but it may result in ForeignCo and the other participants considering and potentially approving the next stage of commercialising the production of the Goods.

At the conclusion of the Project, the facilities will be decommissioned and AusCo will be wound up.

Any assets or intellectual property developed by AusCo, as agent for ForeignCo, will belong to ForeignCo.

ForeignCo will not be contributing a significant amount of assets to the Project.

Other than the Project and the non-Project activities (the passive investments, trading activities and joint research activities) in Australia, ForeignCo is not involved in any other Australian projects. ForeignCo has an Australian permanent establishment in respect of its trading activities but does not have an Australian permanent establishment in respect of the passive investments and joint research activities.

The purpose and goal of the Project and the Project activities is just one of the numerous purposes and goals of the many businesses of ForeignCo's global enterprise.

The purpose and goal of the Project and the Project activities is different to the purpose and goal of Foreign Cos non-Project activities.

The purposes of the Project and the non-Project activities of ForeignCo in Australia do not overlap with one another nor do they have any commonality.

The Project and the activities to be carried out in by AusCo, as agent for ForeignCo, are relatively insignificant when compared to ForeignCo's enterprise.

Project agreements

ForeignCo entered into an agreement with AusCo appointing AusCo as its agent for the sole purpose of carrying out certain activities in Australia in relation to the Project to which ForeignCo has obligations and responsibilities (Project activities).

AusCo was incorporated solely to act as ForeignCo's agent in respect of the Project activities and is not involved in any other projects (in or out of Australia).

The Project activities to be carried out in Australia by AusCo, as agent for ForeignCo, are also scientific research in nature.

ForeignCo entered into other agreements with Project participants in respect of the funding and construction activities which refer to AusCo as ForeignCo's agent in relation to the Project activities.

ForeignCo provides guarantees in relation to the performance of the Project activities by AusCo.

Funding

Under a funding agreement, the government provides funding to Project participants, in the form of government payments, to assist with the costs of the Project.

The government payments are initially received by a designated recipient (which is neither ForeignCo nor AusCo) before the relevant amount is allocated and distributed to each Project participant, but only after the relevant milestone is achieved. The designated recipient only ever holds the government payment for the benefit of the relevant Project participant.

The government payments specifically allocated to ForeignCo (the Subsidies) will initially be received by the designated recipient who will hold the Subsidies for the benefit of ForeignCo. The Subsidies will then be distributed to AusCo upon achievement of the relevant milestones in respect of the Project activities.

The Subsidies are received by AusCo in its capacity as an agent for ForeignCo. It will only be used for the purposes of the Project activities that AusCo will carry out as agent for ForeignCo.

Relevant legislative provisions

Reasons for decision

Government payments received by businesses may be assessable under section 6-5 as ordinary income or section 15-10 as a bounty or subsidy. If neither applies, the assessable recoupment under Subdivision 20-A rules could apply.

ForeignCo is a participant, along with other Project participants, in a Project that involves scientific research located in Australia.

Under the relevant Project agreements, AusCo was incorporated solely to act as agent for ForeignCo in respect of carrying out the Project activities to which ForeignCo has responsibility and obligations under the Project agreements.

Project participants will receive government payments under the funding agreement to assist with the costs of the Project. AusCo will receive government payments (Subsidies) but only in its capacity as an agent for ForeignCo. AusCo is required to only use the Subsidies for the Project activities.

Neither the entity that initially receives the government payments (for distribution to the relevant Project participants upon achievement of milestones) nor AusCo has any interest in the government payments received. It is the relevant Project participant such as ForeignCo who is beneficially entitled to the government payments under the funding agreement.

In respect of the Subsidies, it is ForeignCo who will be beneficially entitled to the amount notwithstanding that AusCo receives the Subsidies and uses it for the purposes of carrying out the Project activities on behalf of ForeignCo.

Taxation Ruling TR 2004/5: Income Tax: taxation treatment of volume rebates paid to a retailer association (TR 2004/5) sets out the Commissioner's view on the deductibility of contributions and derivation of income where it involves an agency in relevant circumstances. The following paragraphs of TR 2004/5 are relevant:

- Para 12 - '...the volume rebate is not included in the [agent's] assessable income under section 6-5 of the ITAA 1997'

- Para 47 - '...volume rebates paid under the arrangement are not included in the association's assessable income when they are received by the association as agent for the retailer. There is no derivation by the association at that point in time because the association only receives the rebates as agent for the association, not for its own benefit'

- Para 51 - 'Money held by an agent on a principal's behalf is in the dominion of the principal.

The effect of the Project agreements, including the funding agreement, is such that for tax purposes ForeignCo will be the entity (and not AusCo) that is beneficially entitled to, and derives, the Subsidies.

Therefore, the Subsidies will be included in the assessable income of ForeignCo for Australian tax purposes subject to the combined operation of the relevant tax treaty and domestic tax laws.

Tax treaty

Where ForeignCo derives Australian-sourced income such as the Subsidies, it would ordinarily be included in its assessable income either as ordinary income under subsection 6-5(3) or statutory income under section 15-10 (as assessable bounties). If neither applies, the assessable recoupment rules under Subdivision 20-A could apply to ForeignCo.

However, Australia's right to tax ForeignCo on the Subsidies may be affected by the application of the Tax Treaty which states that where ForeignCo partly or solely carries on its business through an Australian permanent establishment, to the extent the business profits of ForeignCo is attributable to that Australian permanent establishment then those profits will be taxable in Australia in the hands of ForeignCo.

Permanent establishment

For the purposes of the permanent establishment article in the Tax Treaty, there is a fixed place of business in the State to which ForeignCo carries on a part of its enterprise. In addition, AusCo is a dependent agent for ForeignCo because it carries out the Project activities in the State solely on behalf of ForeignCo.

Accordingly, and subject to certain exemptions, there is an Australian permanent establishment to which ForeignCo partly carries on its enterprise, through its dependent agent, AusCo.

However, there is also an exemption to the permanent establishment article if the activities carried out in Australia by AusCo are only preparatory or auxiliary in nature.

The OECD, 2017, Model Convention With Respect To Taxes On Income and On Capital, 21 November 2017, OECD Publishing, Paris (OECD Model Tax Convention) offers guidance as to what constitute activities that are preparatory or auxiliary character.

Paragraph 59 - 'The decisive criterion is whether or not the activity of the fixed place of business in itself forms an essential and significant part of the activity of the enterprise as a whole...a fixed place of business whose general purpose is one which is identical to the general purpose of the whole enterprise does not exercise a preparatory or auxiliary activity'

Paragraph 60 - 'As a general rule, an activity that has a preparatory character is one that is carried on in contemplation of the carrying on of what constitutes the essential and significant part of the activity of the enterprise as a whole...since a preparatory activity precedes another activity, it will often be carried on during a relatively short period, the duration of that period being determined by the nature of the core activities of the enterprise...it is unlikely that an activity that requires a significant proportion of the assets or employees of the enterprise could be considered as having an auxiliary character'

Paragraph 61 - 'A permanent establishment would therefore exist if such activities were performed on behalf of other enterprises at the same fixed place of business. If, for instance, an enterprise that maintained an office for the advertising of its own products or services were also to engage in advertising on behalf of other enterprises at that location, that office would be regarded as a permanent establishment of the enterprise by which it is maintained.'

Para 71 - Examples of places of business covered by subparagraph e) are fixed places of business used solely for the purpose...for scientific research... Paragraph 4 would not apply, however...if a research establishment were to concern itself with manufacture.

Having regard to guidance from the OECD Model Tax Convention, the Project activities carried out in Australia by AusCo, as agent for ForeignCo, are considered not essential and not significant to ForeignCo's enterprise. The activities are scientific research in nature. The Project is not expected to return a profit nor is it expected that any output of Goods will have any commercial value. ForeignCo will also not be contributing a significant amount of assets to the Project. The Project activities are also relatively insignificant compared to ForeignCo's enterprise. Furthermore, if the Project activities and the Project itself are not successful ForeignCo is not financially impacted. Finally, the purpose and goal of the Project and the Project activities is just one of the numerous purposes and goals of the many businesses of ForeignCo's global enterprise.

Therefore, the Project activities are considered not essential and not significant to ForeignCo's global enterprise and consequently the Project activities carried out by AusCo on behalf of ForeignCo are only preparatory and auxiliary in nature.

Multilateral instrument

The multilateral instrument introduced the anti-fragmentation rule which causes the permanent establishment specific activity exemptions not to apply having regard to the circumstances of the foreign resident and associated entities and the nature of the activities that are being carried out.

The purposes of the Project and the Project activities do not overlap with the purposes of the non-Project activities of ForeignCo nor do they have any commonality. Accordingly, their overall activities do not constitute complementary functions that form a cohesive business that could result in a permanent establishment. Therefore, the multilateral instrument modifying the permanent establishment article in the Tax Treaty does not apply and ForeignCo does not have an Australian permanent establishment in respect of the Project activities carried out by its agent AusCo.

Tax treatment of Subsidies

Consequently, the Tax Treaty applies to treat the Subsidies received by ForeignCo's agent, AusCo, as being taxable in the hands of ForeignCo only in ForeignCo's country of residence. As a result the Subsidies are not assessable income of ForeignCo for Australian tax purposes.